Grayson Bankshares (GSON) 10-Q 2010 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2010

[   ] Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number:  0-30535

GRAYSON BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

Virginia (State or other jurisdiction of incorporation or organization)	54-1647596 (I.R.S. Employer Identification No.)
113 West Main Street Independence, Virginia (Address of principal executive offices)	24348 (Zip Code)

(276) 773-2811

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   o    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o     Accelerated filer  o

Non-accelerated filer  o (Do not check if smaller reporting company) Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

1,718,968 shares of Common Stock, par value

$1.25 per share, outstanding as of May 14, 2010.

PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets—March 31, 2010 (Unaudited)
	and December 31, 2009 (Audited)	3
	Unaudited Consolidated Statements of Income—Three Months Ended
	March 31, 2010 and March 31, 2009	4
	Consolidated Statements of Changes in Stockholders’ Equity—Three Months
	Ended March 31, 2010 (Unaudited) and Year Ended December 31, 2009 (Audited)	5
	Unaudited Consolidated Statements of Cash Flows—Three Months Ended
	March 31, 2010 and March 31, 2009	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition
	and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	20
Item 4.	Controls and Procedures	21
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	22
Item 1A.	Risk Factors	22
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 3.	Defaults Upon Senior Securities	22
Item 4.	Removed and Reserved	22
Item 5.	Other Information	22
Item 6.	Exhibits	22
Signatures		23

Part I.  Financial Information

Item 1.  Financial Statements

Grayson Bankshares, Inc. and Subsidiary

Consolidated Balance Sheets

March 31, 2010 and December 31, 2009

	March 31,			December 31,
	2010			2009
Assets	(Unaudited)			(Audited)
Cash and due from banks	$	9,469,485		$	8,637,123
Interest-bearing deposits with banks		300,188			300,000
Federal funds sold		21,299,796			19,356,999
Investment securities available for sale		40,728,939			39,859,119
Investment securities held to maturity
(fair value approximately $2,297,321 at March 31, 2010,
and $2,254,196 at December 31,  2009)		2,186,446			2,174,882
Restricted equity securities		1,783,700			1,783,700
Loans, net of allowance for loan losses of $3,744,934 at
March 31, 2010 and $3,555,273 at December 31, 2009		262,850,283			266,628,050
Cash value of life insurance		8,173,134			8,098,134
Foreclosed assets		2,786,385			2,808,885
Property and equipment, net		11,034,756			11,133,834
Accrued interest receivable		2,294,589			2,626,164
Other assets		6,071,150			6,195,031
	$	368,978,851		$	369,601,921
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest-bearing	$	43,309,657		$	44,924,699
Interest-bearing		268,405,679			268,558,517
Total deposits		311,715,336			313,483,216
Long-term debt		25,000,000			25,000,000
Accrued interest payable		782,944			382,653
Other liabilities		543,387			196,107
		338,041,667			339,061,976
Commitments and contingencies		-			-
Stockholders’ equity
Preferred stock, $25 par value; 500,000
shares authorized; none issued		-			-
Common stock, $1.25 par value; 2,000,000 shares
authorized; 1,718,968 shares issued
in 2010 and 2009, respectively		2,148,710			2,148,710
Surplus		521,625			521,625
Retained earnings		28,734,401			28,497,214
Accumulated other comprehensive income (loss)		(467,552	)		(627,604	)
		30,937,184			30,539,945
	$	368,978,851		$	369,601,921

See Notes to Consolidated Financial Statements.

3

Grayson Bankshares, Inc. and Subsidiary

Consolidated Statements of Income

For the Three Months ended March 31, 2010 and 2009

	Three Months Ended
	March 31,
	2010		2009
	(Unaudited)		(Unaudited)
Interest income
Loans and fees on loans	$	4,305,442	$	4,574,039
Interest-bearing deposits in banks		210		-
Federal funds sold		9,291		10,633
Investment securities:
Taxable		336,277		435,022
Exempt from federal income tax		93,740		111,079
		4,744,960		5,130,773
Interest expense
Deposits		1,467,909		2,027,201
Interest on borrowings		260,463		310,899
		1,728,372		2,338,100
Net interest income		3,016,588		2,792,673
Provision for loan losses		286,508		134,834
Net interest income after
provision for loan losses		2,730,080		2,657,839
Noninterest income (loss)
Service charges on deposit accounts		232,738		209,150
Increase in cash value of life insurance		75,000		78,000
Net realized gains (losses) on securities		35,957		25,467
Other income		164,969		160,815
		508,664		473,432
Noninterest expense
Salaries and employee benefits		1,565,785		1,641,713
Occupancy expense		136,128		120,215
Equipment expense		195,738		206,937
Other expense		813,009		531,988
		2,710,660		2,500,853
Income before income taxes		528,084		630,418
Income tax expense		119,000		167,000
Net income	$	409,084	$	463,418
Basic earnings  per share	$	0.24	$	0.27
Weighted average shares outstanding		1,718,968		1,718,968
Dividends declared per share	$	0.10	$	0.10

See Notes to Consolidated Financial Statements.

4

Grayson Bankshares, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

For the Three Months ended March 31, 2010 (unaudited) and the Year ended December 31, 2009(audited)

										Accumulated
										Other
	Common Stock						Retained			Comprehensive
	Shares		Amount		Surplus		Earnings			Income (Loss)			Total
Balance, December 31, 2008		1,718,968	$	2,148,710	$	521,625	$	28,302,082		$	(1,955,722	)	$	29,016,695
Comprehensive income
Net income		-		-		-		882,719			-			882,719
Net change in pension reserve											-
net of income taxes of $555,893		-		-		-		-			1,079,087			1,079,087
Net change in unrealized
gain on investment
securities available for
sale, net of taxes of $203,119		-		-		-		-			394,290			394,290
Reclassification adjustment,
net of income taxes of ($74,830) -		-		-		-		-			(145,259	)		(145,259	)
Total comprehensive income														2,210,837
Dividends paid
($.40 per share)		-		-		-		(687,587	)		-			(687,587	)
Balance, December 31, 2009		1,718,968	$	2,148,710	$	521,625	$	28,497,214		$	(627,604	)	$	30,539,945
Comprehensive income
Net income		-		-		-		409,084			-			409,084
Net change in unrealized
loss on investment
securities available for
sale, net of taxes of  $94,677		-		-		-		-			183,784			183,784
Reclassification adjustment,
net of income taxes of ($12,226) -		-		-		-		-			(23,732	)		(23,732	)
Total comprehensive income														569,136
Dividends paid
($.10 per share)		-		-		-		(171,897	)		-			(171,897	)
Balance, March 31, 2010		1,718,968	$	2,148,710	$	521,625	$	28,734,401		$	(467,552	)	$	30,937,184

See Notes to Consolidated Financial Statements.

5

Grayson Bankshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows

For the Three Months ended March 31, 2010 and 2009

	Three Months Ended
	March 31,
	2010			2009
	(Unaudited)			(Unaudited)
Cash flows from operating activities
Net income	$	409,084		$	463,418
Adjustments to reconcile net income
to net cash provided by operations:
Depreciation and amortization		190,500			205,500
Provision for loan losses		286,508			134,834
Deferred income taxes		(82,000	)		(48,000	)
Net realized gains on securities		(35,957	)		(25,467	)
Accretion of discount on securities, net of
amortization of premiums		51,933			15,297
Deferred compensation		(8,512	)		(2,845	)
Net realized loss on foreclosed assets		275			-
Changes in assets and liabilities:
Cash value of life insurance		(75,000	)		(78,000	)
Accrued income		331,575			466,657
Other assets		123,430			(22,213	)
Accrued interest payable		400,291			433,381
Other liabilities		355,792			114,494
Net cash provided by operating activities		1,947,919			1,657,056
Cash flows from investing activities
Net increase in interest-bearing deposits		(188	)		-
Net increase in federal funds sold		(1,942,797	)		(9,899,232	)
Purchases of available-for-sale investment securities		(15,417,695	)		(11,048,603	)
Sales of available-for-sale investment securities		1,056,563			2,877,961
Maturities/calls/paydowns of available-for-sale investment securities		13,706,276			10,270,704
Net decrease in loans		3,491,259			3,318,014
Proceeds from the sale of foreclosed assets		22,224			-
Purchases of property and equipment, net of sales		(91,422	)		(276,497	)
Net cash provided by (used in) investing activities		824,220			(4,757,653	)
Cash flows from financing activities
Net increase (decrease) in deposits		(1,767,880	)		5,082,856
Dividends paid		(171,897	)		(171,897	)
Net cash (used in) provided by financing activities		(1,939,777	)		4,910,959
Net increase in cash and cash equivalents		832,362			1,810,362
Cash and cash equivalents, beginning		8,637,123			9,536,772
Cash and cash equivalents, ending	$	9,469,485		$	11,347,134
Supplemental disclosure of cash flow information
Interest paid	$	1,328,081		$	1,904,719
Taxes paid	$	-		$	190,000
Transfers of loans to foreclosed properties	$	-		$	87,388

See Notes to Consolidated Financial Statements.

6

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 1.  Organization and Summary of Significant Accounting Policies

Organization

Grayson Bankshares, Inc. (the “Company”) was incorporated as a Virginia corporation on February 3, 1992 to acquire the stock of The Grayson National Bank (the “Bank”) in a bank holding company reorganization.  The Bank was acquired by the Company on July 1, 1992.

The Bank was organized under the laws of the United States in 1900 and currently serves Grayson County, Virginia and surrounding areas through ten banking offices.  As an FDIC-insured National Banking Association, the Bank is subject to regulation by the Comptroller of the Currency.  The Company is regulated by the Board of Governors of the Federal Reserve System.

The consolidated financial statements as of March 31, 2010 and for the periods ended March 31, 2010 and 2009 included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.  In the opinion of management, the information furnished in the interim consolidated financial statements reflects all adjustments necessary to present fairly the Company’s consolidated financial position, results of operations, changes in stockholders’ equity and cash flows for such interim periods.  Management believes that all interim period adjustments are of a normal recurring nature.  These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the not es thereto as of December 31, 2009, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009.  The results of operations for the three-month period ended March 31, 2010 are not necessarily indicative of the results to be expected for the full year.

The accounting and reporting policies of the Company and the Bank follow generally accepted accounting principles and general practices within the financial services industry.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and the Bank, which is wholly owned.  All significant intercompany transactions and balances have been eliminated in consolidation.

Recent Accounting Pronouncements

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation.  The new disclosures are effective for the Company for the current quarter and have been reflected in Note 8 below.

Guidance related to subsequent events was amended in February 2010 to remove the requirement for an SEC filer to disclose the date through which subsequent events were evaluated.  The amendments were effective upon issuance and had no significant impact on the Company’s financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

7

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 2.  Restrictions on Cash

To comply with banking regulations, the Bank is required to maintain certain average cash reserve balances.  The daily average cash reserve requirement was approximately $1,656,000 and $1,612,000 for the periods including March 31, 2010 and December 31, 2009, respectively.

Note 3.  Investment Securities

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent.  The carrying amount of securities and their approximate fair values at March 31, 2010 and December 31, 2009 follow:

	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
March 31, 2010
Available for sale:
U.S. Government agency securities	$	1,515,190	$	82,471	$	-	$	1,597,661
Government sponsored enterprises		13,951,859		44,037		178,231		13,817,665
Mortgage-backed securities		17,159,843		680,450		-		17,840,293
State and municipal securities		7,279,931		232,142		38,753		7,473,320
	$	39,906,823	$	1,039,100	$	216,984	$	40,728,939
Held to maturity:
State and municipal securities	$	2,186,446	$	112,784	$	1,909	$	2,297,321
December 31, 2009
Available for sale:
U.S. Government agency securities	$	1,629,026	$	81,689	$	-	$	1,710,715
Government sponsored enterprises		13,067,890		38,375		204,195		12,902,070
Mortgage-backed securities		17,295,436		560,310		-		17,855,746
State and municipal securities		7,287,155		162,768		59,335		7,390,588
	$	39,279,507	$	843,142	$	263,530	$	39,859,119
Held to maturity:
State and municipal securities	$	2,174,882	$	86,889	$	7,575	$	2,254,196

There were no securities transferred between the available for sale and held to maturity portfolios during the three-month period ended March 31, 2010 or the year ended December 31, 2009.

Restricted equity securities were $1,783,700 at March 31, 2010 and December 31, 2009.  Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (“FHLB”), Community Bankers Bank, Pacific Coast Bankers Bank, and the Federal Reserve Bank of Richmond, all of which are carried at cost.  All of these entities are upstream correspondents of the Bank.  The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow money.  The Bank is required to hold that stock so long as it borrows from the FHLB.  The Federal Reserve requires Banks to purchase stock as a condition for membership in the Federal Reserve system.  The Bank’s stock in Community Bankers Bank and Pacific C oast Bankers Bank is restricted only in the fact that the stock may only be repurchased by the respective banks.

8

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 3.  Investment Securities, continued

The following table details unrealized losses and related fair values in the Company’s held to maturity and available for sale investment securities portfolios.  This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2010 and December 31, 2009.

	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
March 31, 2010
Available for sale
U.S. Government agency securities	$	-	$	-	$	-	$	-	$	-	$	-
Government sponsored enterprises		8,382,891		118,890		1,978,120		59,341		10,361,011		178,231
Mortgage-backed securities		-		-		-		-		-		-
State and municipal securities		-		-		720,802		38,753		720,802		38,753
Total securities available for sale	$	8,382,891	$	118,890	$	2,698,922	$	98,094	$	11,081,813	$	216,984
Held to maturity
State and municipal securities	$	-	$	-	$	225,747	$	1,909	$	225,747	$	1,909
December 31, 2009
Available for sale
U.S. Government agency securities	$	-	$	-	$	-	$	-	$	-	$	-
Government sponsored enterprises		5,454,054		204,195		-		-		5,454,054		204,195
Mortgage-backed securities		-				-				-		-
State and municipal securities		1,006,692		8,439		708,900		50,896		1,715,592		59,335
Total securities available for sale	$	6,460,746	$	212,634	$	708,900	$	50,896	$	7,169,646	$	263,530
Held to maturity
State and municipal securities	$	-	$	-	$	220,031	$	7,575	$	220,031	$	7,575

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.  Consideration is given to the length of time and the extent to which the fair value has been less than cost, and the financial condition and near-term prospects of the issuer.  The relative significance of these and other factors will vary on a case by case basis.

In analyzing an issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer's financial condition and the issuer's anticipated ability to pay the contractual cash flows of the investments. Since the Company intends to hold all of its investment securities until maturity, and it is more likely than not that the Company will not have to sell any of its investment securities before unrealized losses have been recovered, and the Company expects to recover the entire amount of the amortized cost basis of all its securities, none of the securities are deemed other than temporarily impaired at March 31, 2010. Management continues to monitor all of these securiti es with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which could require a charge to earnings in such periods.

9

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 3.  Investment Securities, continued

Investment securities with amortized cost of approximately $16,315,015 at March 31, 2010 and $15,278,151 at December 31, 2009, were pledged as collateral on public deposits and for other purposes as required or permitted by law.  Gross realized gains and losses for the three-month periods ended March 31, 2010 and 2009 are as follows:

	2010		2009
Realized gains	$	35,957		82,992
Realized losses		-		(57,525	)
	$	35,957	$	25,467

The scheduled maturities of securities available for sale and securities held to maturity at March 31, 2010, were as follows:

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Due in one year or less	$	340,259	$	343,913	$	-	$	-
Due after one year through five years		2,163,854		2,261,726		1,479,077		1,562,799
Due after five years through ten years		11,635,459		12,102,633		-		-
Due after ten years		25,767,251		26,020,667		707,369		734,522
	$	39,906,823	$	40,728,939	$	2,186,446	$	2,297,321

Maturities of mortgage backed securities are based on contractual amounts.  Actual maturity will vary as loans underlying the securities are prepaid.

Note 4.  Allowance for Loan Losses

The following is an analysis of the allowance for loan losses for the three months ended March 31, 2010 and 2009.

	2010			2009
Balance, beginning	$	3,555,273		$	3,359,946
Provision charged to expense		286,508			134,834
Recoveries of amounts charged off		39,101			7,546
Amounts charged off		(135,948	)		(135,766	)
Balance, ending	$	3,744,934		$	3,366,560

Note 5.  Income Taxes

A reconciliation of income tax expense computed at the statutory federal income tax rate to income tax expense included in the statements of income for the three months ended March 31, 2010 and 2009 follows:

	2010			2009
Tax at statutory federal rate	$	179,549		$	214,342
Tax exempt interest income		(41,690	)		(39,625	)
Other tax exempt income		(25,500	)		(26,520	)
Other		6,641			18,803
	$	119,000		$	167,000

10

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 6.  Employee Benefit Plan

The Bank has a qualified noncontributory defined benefit pension plan that covers substantially all of its employees.  The benefits are primarily based on years of service and earnings.  The following is a summary of net periodic pension costs for the three-month periods ended March 31, 2010 and 2009.

	March 31,
	2010			2009
Service cost	$	102,960			97,769
Interest cost		104,258			95,369
Expected return on plan assets		(165,071	)		(89,534	)
Amortization of net obligation at transition		-			(5	)
Amortization of prior service cost		808			2,695
Amortization of net (gain) or loss		9,699			36,101
Net periodic benefit cost	$	52,654		$	142,395

It is Bank policy to contribute the maximum tax-deductible amount each year as determined by the plan administrator.  No contribution to the plan was made during the three month period ended March 31, 2010.  Based on current information, it is anticipated the 2010 contribution will be approximately $772,933 and will be made sometime in the second quarter of 2010.

Note 7.  Commitments and Contingencies

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the consolidated balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments.  A summary of the Bank’s commitments at March 31, 2010 and 2009 is as follows:

	2010		2009
Commitments to extend credit	$	17,090,964	$	18,771,928
Standby letters of credit		-		-
	$	17,090,964	$	18,771,928

Commitments to extend credit are agreements to lend to a customer, at a fixed or variable interest rate, as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Bank evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party.   Collateral held varies, but may include accounts receivable, inven tory, property and equipment, residential real estate and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances that the Bank deems necessary.

11

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 8.  Fair Value

FASB ASC 825, “Financial Instruments”, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments.  FASB ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.  Accordin gly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and due from banks:  The carrying amounts reported in the balance sheet for cash and due from banks approximate their fair values.

Interest-bearing deposits with banks:  Due to their short-term nature, the carrying value of federal funds sold approximate their fair value.

Federal funds sold:  Due to their short-term nature, the carrying value of federal funds sold approximate their fair value.

Securities:  Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.  The carrying values of restricted equity securities approximate fair values.

Loans receivable:  For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts.  The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable.  The carrying amount of accrued interest receivable approximates its fair value.

Cash value of life insurance:  The carrying amount reported in the balance sheet approximates fair value as it represents the cash surrender value of the life insurance.

Deposit liabilities:  The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date.  The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.  The carrying amount of accrued interest payable approximates fair value.

Long-term debt:  The fair value of long-term debt is estimated using a discounted cash flow calculation that applies interest rates currently available on similar instruments.

12

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 8.  Fair Value, continued

The estimated fair values of the Company’s financial instruments are as follows (dollars in thousands):

	March 31, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial assets
Cash and due from banks	$	9,469	$	9,469	$	8,637	$	8,637
Interest bearing deposits with banks		300		300		300		300
Federal funds sold		21,300		21,300		19,357		19,357
Securities, available for sale		40,729		40,729		39,859		39,859
Securities, held to maturity		2,186		2,297		2,175		2,254
Restricted equity securities		1,784		1,784		1,784		1,784
Loans, net of allowance for loan losses		262,850		264,248		266,628		269,442
Cash value of life insurance		8,173		8,173		8,098		8,098
Accrued interest receivable		2,295		2,295		2,626		2,626
Financial liabilities
Deposits		311,715		314,080		313,483		315,789
Long-term debt		25,000		26,566		25,000		27,511
Accrued interest payable		783		783		383		383

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  Securities available for sale, and derivatives are recorded at fair value on a recurring basis.  Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans or foreclosed assets.  These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

Under FASB ASC 820, “Fair Value Measurements and Disclosures”, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market.  These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques may include the use of option pricing models, discounted cash flow models and similar techniques.

13

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 8.  Fair Value, continued

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis.  Fair value measurement is based upon quoted prices, if available.  If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.  Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds.  Level 2 securities include mortgage-backed securities issued by government sponsored entities, mu nicipal bonds and corporate debt securities.  Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans

The Company does not record loans at fair value on a recurring basis.  However, from time to time, a loan is considered impaired and an allowance for loan losses is established.  Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired.  Once a loan is identified as individually impaired, management measures impairment in accordance with FASB ASC 310, “Receivables”.   The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.  Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.  At March 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral.  In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Derivative Assets and Liabilities

Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available.  Management engages third-party intermediaries to determine the fair market value of these derivative instruments and classifies these instruments as Level 2.  Examples of Level 2 derivatives are interest rate swaps, caps and floors.  No derivative instruments were held as of March 31, 2010, or December 31, 2009.

Foreclosed Assets

Foreclosed assets are adjusted to fair value, less selling costs, upon transfer of the loans to foreclosed assets.  Subsequently, foreclosed assets are carried at the lower of carrying value or fair value.  Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

14

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 8.  Fair Value, continued

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

March 31, 2010	Total		Level 1		Level 2		Level 3
Investment securities available for sale
U.S. Government agency securities	$	1,597,661	$	-	$	1,597,661	$	-
Government sponsored enterprises		13,817,665		-		13,817,665		-
Mortgage-backed securities		17,840,293		-		17,840,293		-
State and municipal securities		7,473,320		-		7,473,320		-
Total investment securities available for sale	$	40,728,939	$	-	$	40,728,939	$	-
Total assets at fair value	$	40,728,939	$	-	$	40,728,939	$	-
Total liabilities at fair value	$	-	$	-	$	-	$	-
December 31, 2009	Total		Level 1		Level 2		Level 3
Investment securities available for sale
U.S. Government agency securities	$	1,710,715	$	-	$	1,710,715	$	-
Government sponsored enterprises		12,902,070		-		12,902,070		-
Mortgage-backed securities		17,855,746		-		17,855,746		-
State and municipal securities		7,390,588		-		7,390,588		-
Total investment securities available for sale	$	39,859,119	$	-	$	39,859,119	$	-
Total assets at fair value	$	39,859,119	$	-	$	39,859,119	$	-
Total liabilities at fair value	$	-	$	-	$	-	$	-

There were no significant transfers to or from Levels 1 and 2 during the three-month period ended March 31, 2010 or for the year ended December 31, 2009.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles.  These include assets and liabilities that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.  Assets and liabilities measured at fair value on a nonrecurring basis are included in the table below.

March 31, 2010	Total		Level 1		Level 2		Level 3
Loans	$	1,532,034	$	-	$	701,148	$	830,886
Foreclosed assets		308,659		-		67,159		241,500
Total assets at fair value	$	1,840,693	$	-	$	768,307	$	1,072,386
Total liabilities at fair value	$	-	$	-	$	-	$	-

15

Grayson Bankshares, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note 8.  Fair Value, continued

December 31, 2009	Total		Level 1		Level 2		Level 3
Loans	$	1,365,896	$	-	$	637,004	$	728,892
Foreclosed assets		331,159		-		67,159		264,000
Total assets at fair value	$	1,697,055	$	-	$	704,163	$	992,892
Total liabilities at fair value	$	-	$	-	$	-	$	-

Note 9.  Subsequent Events

Management has evaluated events occurring subsequent to the balance sheet date through the date these financial statements were issued, determining no events require additional disclosure in these consolidated financial statements.

16

Part I.  Financial Information

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following discussion provides information about the major components of the results of operations and financial condition of the Company.  This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this report.

Critical Accounting Policies

For a discussion of the Company’s critical accounting policies, including its allowance for loan losses, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

Results of Operations

Overall, pre-tax earnings for the quarter ended March 31, 2010 totaled $528,084 compared to pre-tax earnings of $630,418 for the same period in 2009.   Income tax expense decreased by $48,000 from the first quarter of 2009 to 2010 resulting in net income of $409,084 for the first quarter of 2010 compared to $463,418 for the same period in 2009.

Total interest income decreased by $385,813 for the quarter ended March 31, 2010 compared to the quarter ended March 31, 2009, while interest expense on deposits and other borrowings decreased by $609,728 over the same period.  The decrease in interest income was attributable primarily to decreases in the average outstanding balances of both loans and investment securities for the first quarter of 2010 as compared to the same quarter in 2009, an increase in the amount of loans on non-accrual status, and a decrease in the average yield on investment securities in the first quarter of 2010 compared to 2009.  The decreased loan demand allowed management to more aggressively lower interest rates on deposits, leading to the greater reduction in interest expense.   The result was an inc rease in net interest income of $223,915, or 8.02% for the quarter ended March 31, 2010, compared to the same quarter last year.

The provision for loan losses was $286,508 for the quarter ended March 31, 2010 and $134,834 for the same period in 2009.  The increase was due to increased charge-offs as well as management’s desire to maintain higher reserve levels in light of deteriorating economic conditions and increases in the level of past-due loans.  The reserve for loan losses at March 31, 2010 was approximately 1.40% of total loans, compared to 1.26% at March 31, 2009.  Management believes the provision and the resulting allowance for loan losses are adequate.

Total noninterest income was $508,664 in the first quarter of 2010 compared to $473,432 in the first quarter of 2009.  The majority of the increase came as a result of increased service charges on deposit accounts.

Noninterest expenses increased by $209,807, or 8.39%, for the quarter ended March 31, 2010 compared to the quarter ended March 31, 2009.  Salary and employee benefit expenses decreased by $75,928, or 4.62% due to employee attrition and reductions in benefit costs.  Occupancy expense increased by $15,913, or 13.24% due to a significant increase in local utility rates.  Other expenses increased by $281,021, or 52.82%.  The increase in other expenses in 2010 was due primarily to credits in provisions for overdraft losses of approximately $170,000 that were recognized in 2009 which did not recur in 2010.  FDIC assessments also increased in the first quarter of 2010 by approximately $72,000 compared to the first quarter of 2009.

17

Part I.  Financial Information

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial Condition

Total assets decreased by $623,070, or 0.17%, from December 31, 2009 to March 31, 2010.  Net loans decreased by $3,777,767, federal funds sold increased by $1,942,797 and investment securities increased by $881,384.

Total deposits decreased by $1,767,880, or 0.56%, from December 31, 2009 to March 31, 2010.  The decrease in deposits came as management moved to lower deposit rates in conjunction with the decreases in rates on loans and federal funds sold, combined with decreasing loan demand.

Nonperforming assets, including nonaccrual loans, loans past due more than ninety days and foreclosed assets, increased from $18,130,704 at December 31, 2009 to $19,011,872 at March 31, 2010.  Foreclosed assets consist of nine properties totaling $2,786,385 at March 31, 2010.  One commercial real estate property represents the majority of the balance in foreclosed assets with a value of $2,422,726.  The remaining properties include five residential real estate properties, one commercial building, and two tracts of undeveloped land.  There was one disposal of a foreclosed property in the first quarter of 2010 which resulted in a loss of $275.  All foreclosed properties are being marketed for sale.  Loans past due more than ninety days increased from $1,163, 076 at December 31, 2009 to $3,272,306 at March 31, 2010.

Nonaccrual loans decreased from $14,158,743 at December 31, 2009 to $12,953,181 at March 31, 2010.  During the first quarter of 2010, loans totaling $1,153,697 were added to nonaccrual status while loans totaling $2,320,600 were removed from nonaccrual status.  Loans are generally placed in nonaccrual status when principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection.  Loans less than 90 days past due may be placed in nonaccrual status if management determines that payment in full of principal or interest is not expected.  Loans are removed from nonaccrual status when they are deemed a loss and charged to the allowance, transferred to foreclosed assets, or returned to accrual status based upon performance consistent with the original terms of the loan or a subsequent restructuring thereof.  Management continues to closely monitor nonperforming assets and their impact on earnings and loan loss reserves.

Certain types of loans, such as option ARM products, interest-only loans, subprime loans and loans with initial teaser rates, can have a greater risk of non-collection than other loans.  The Bank has not offered these types of loans in the past and does not offer them currently.  Junior-lien mortgages can also be considered higher risk loans.  Our junior-lien portfolio at March 31, 2010 totaled $7.0 million, or 2.62% of total loans.  Historical charge-off rates in this category have not varied significantly from other real estate secured loans.

Stockholders’ equity totaled $30,937,184 at March 31, 2010 compared to $30,539,945 at December 31, 2009.  The $397,239 increase was the result of earnings for the three months combined with an increase in the market value of securities classified as available for sale of $160,052, offset by the payment of dividends of $171,897.

Regulatory guidelines relating to capital adequacy provide minimum risk-based ratios at the Bank level which assess capital adequacy while encompassing all credit risks, including those related to off-balance sheet activities.  The Bank exceeds all regulatory capital guidelines and is considered to be “well capitalized.”

18

Part I.  Financial Information

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

Liquidity and Capital Resources

Liquidity is the ability to convert assets to cash to fund depositors’ withdrawals or borrowers’ loans without significant loss.Unsecured federal fund lines available from correspondent banks totaled $9,000,000 at March 31, 2010.  No balances were outstanding on these lines at March 31, 2010 or December 31, 2009.  Long-term debt consists of borrowings from the Federal Home Loan Bank and Deutsche Bank.  Borrowings from the Federal Home Loan Bank, which are secured by a blanket collateral agreement on the Bank’s 1 to 4 family residential real estate loans, totaled $15,000,000 at March 31, 2010 and December 31, 2009.  Borrowings from Deutsche Bank, which are secured by the pledging of specific invest ment securities, totaled $10,000,000 at each of March 31, 2010, and December 31, 2009.  The unused credit line from the Federal Home Loan Bank as of March 31, 2010 is approximately $40,000,000.

The Bank uses cash and federal funds sold to meet its daily funding needs.  If funding needs are met through holdings of excess cash and federal funds, then profits might be sacrificed as higher-yielding investments are foregone in the interest of liquidity.  Therefore management determines, based on such items as loan demand and deposit activity, an appropriate level of cash and federal funds and seeks to maintain that level.

The Bank’s investment security portfolio also serves as a source of liquidity.  The primary goals of the investment portfolio are liquidity management and maturity gap management.  As investment securities mature, the proceeds are reinvested in federal funds sold if the federal funds level needs to be increased; otherwise the proceeds are reinvested in similar investment securities.  The majority of investment security transactions consist of replacing securities that have been called or matured.  The Bank keeps a portion of its investment portfolio in unpledged assets with average lives or repricing terms of less than 60 months.  These investments are a preferred source of funds because their market value is not as sensitive to changes in interest rates as in vestments with longer durations.

As a result of the steps described above, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

Forward-Looking Statements

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.  Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Company, changing trends in customer profiles and changes in laws and regulations applicable to the Company.  Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.  For additional information on known and unknown risks, see the “Forward Looking Statements” section in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

19

Part I.  Financial Information

Item 3.               Quantitative and Qualitative Disclosures about Market Risk

Not applicable to smaller reporting companies.

20

Part I.  Financial Information

Item 4.               Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934.  Based upon that evaluation, the Company’s President and Chief Executive Officer and Chief Financial Officer concluded that its disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiary) required to be included in its periodic filings with the Securities and Exchange Commission.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

21

Part II.  Other Information

Item 1.                     Legal Proceedings

There are no pending legal proceedings to which the Company or the Bank is a party or of which any of their property is subject.

Item 1A.Risk Factors

Not applicable to smaller reporting companies.

Item 2.                     Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Item 3.                     Defaults Upon Senior Securities

Not applicable

Item 4.                     Removed and Reserved

Item 5.                     Other Information

None

Item 6.                     Exhibits

31.1	Rule 13(a)-14(a) Certification of Chief Executive Officer.
31.2	Rule 13(a)-14(a) Certification of Chief Financial Officer.
32.1	Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
	Section 1350.

22

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		GRAYSON BANKSHARES, INC.
Date: May 14, 2010	By:	/s/ Jacky K. Anderson
		Jacky K. Anderson
		President and Chief Executive Officer
	By:	/s/ Blake M. Edwards
		Blake M. Edwards
		Chief Financial Officer

23

Exhibit Index

Exhibit No.	Description
31.1	Rule 13(a)-14(a) Certification of Chief Executive Officer.
31.2	Rule 13(a)-14(a) Certification of Chief Financial Officer.
32.1	Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.

23